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DOJ probes subprime auto-lending under FIRREA

Two of the largest subprime auto-lenders disclosed last week that they have received subpoenas from the U.S. Department of Justice (DOJ). The U.S. Attorney’s Office for the Southern District of New York is leading an investigation into the origination and securitization practices of subprime automobile lenders. The subpoenas were issued under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA), which the government has used in recent years to extract large settlements in cases involving subprime mortgages. The government appears to suspect that the auto-lending industry suffers from deficiencies similar to those uncovered in residential mortgage-backed securities (RMBS) investigations.

This DOJ probe comes on the heels of a New York Times article last month reporting on aggressive lending practices in the subprime auto-loan industry and alleging that lenders are making high-interest loans to marginal borrowers, which sounds reminiscent of practices that led to the housing crisis. As in the RMBS cases, the government is focused on how subprime auto-lenders made and packaged loans to consumers and whether they properly reviewed and represented the quality of those loans to purchasers. Specifically, the subpoenas request information relating to the underwriting criteria used to originate automobile loan contracts and the representations and warranties made by the lenders relating to those underwriting criteria.

Over the past five years of RMBS investigations and lawsuits, the government developed a relatively novel legal theory based on FIRREA, which was a congressional response to the savings and loan crisis in the 1980s. FIRREA authorizes the government to bring a civil action based on violations of various criminal statues as long as the conduct at issue “affects” “a federally insured financial institution.” The government chose FIRREA as its prosecutorial weapon of choice in RMBS cases because of its (1) broad scope, encompassing a wide range of conduct; (2) lower evidentiary threshold, applying civil standards to quasi-criminal acts without providing the protections of criminal law; and (3) ten-year statute of limitations.

The DOJ is now using the same playbook to probe the subprime auto-lending industry. The same office that is leading the investigation into these subprime auto-lenders was involved in major RMBS actions based on FIRREA against companies for its mortgage origination practices. It appears that the government is now searching for issues like auto-loan servicing misconduct, loan origination problems, and securities misrepresentations.

Industry experts are quick to note the many differences between auto- and mortgage-backed securities, including the fact that auto-loan securitizations never experienced losses during the capital markets crisis and continue to perform well. Nonetheless, the government’s investigation appears likely to expand in the coming months to other auto-lenders and possibly underwriters and rating agencies as well. It remains to be seen whether the government’s legal theory based on FIRREA will work in the context of auto-lending.